Mauboussin Addresses 'Short Termism' at Morningstar U.S. Conference

Short-term thinking and its detrimental effects are rife in the business and investment worlds, but so are opportunities for investors who don't follow the herd ....

Lawrence Jones 04 July, 2006 | 0:00
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Short-term thinking and its detrimental effects are rife in the business and investment worlds, but so are opportunities for investors who don't follow the herd, said Legg Mason Capital Management's chief investment strategist, Michael Mauboussin, at Morningstar's 2006 Investment Conference in the U.S. this week.

One reason for the business world's increased focus on short-term results over the past couple of decades has been a transformation in the way executives are compensated. According to Mauboussin, in 1985 about 1% of a CEO's pay was tied to the performance of his or her company's stock price, but by 2005 a full 60% of compensation was stock-price related. That gave CEOs incentive to maximize thei

r companies' stock prices and, unfortunately, fixate on earnings-per-share growth, Mauboussin said. This fixation evolved even though the linkage between EPS growth and value creation is tenuous, stated Mauboussin. Therefore, in seeking to maximize their compensation, executives made decisions that had a deleterious effect on the long-term health of the company and on long-term shareholder value, he said.

Why should we care? According to Mauboussin, research has shown that short-termism in investing--for instance, as displayed by higher levels of portfolio turnover--can cost investors a great deal in both transaction and market-impact cost. In fact, in a study he conducted for Legg Mason, he identified low portfolio turnover as one factor that has led some firms' investment strategies to outpace others'.

Factors that also seem to help are running portfolios in a concentrated style and focusing on intrinsic value investing. Interestingly, a firm's geographic location was another factor. The research suggests that investment advisors located in financial hubs, like New York and Boston, may have to sort through a great deal more informational "noise" than those located in more peripheral areas of the investment world, which puts them at a disadvantage.

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Lawrence Jones  Lawrence Jones is a Senior Mutual Fund Analyst with Morningstar.

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